Title: European Economy Faces Weakness Amidst Rising Inflation and Interest Rate Hikes
Subtitle: Inflation persists as businesses prioritize profits over workers, causing concerns over economic growth
Europe’s economy has experienced a significant weakening over the past year, despite being more resilient than initially predicted. Inflation-adjusted wages and consumer confidence have declined, signaling potential challenges ahead. While growth is expected to improve, the economy could face setbacks due to further increases in interest rates.
Gita Gopinath, the first deputy managing director of the International Monetary Fund (IMF), recently emphasized the importance of central banks addressing inflation rates, even if it means risking weaker economic growth. This statement reflects the concerns shared by many central banks, including the European Central Bank (ECB), which has already indicated the likelihood of rate increases in July and September.
Christine Lagarde, President of the ECB, speaking at the central bank’s 10th annual conference in Sintra, Portugal, commented on the persistently high inflation in the Eurozone. Lagarde expressed the need to address the high inflation levels and stressed that they are expected to remain elevated for an extended period. However, these rapid rate increases have faced criticism from political leaders like Giorgia Meloni, Italy’s Prime Minister, who denounced the ECB’s approach to raising interest rates.
The background explains that inflation in the Eurozone reached a peak of 10.6% in October, driven by surging energy and food prices following the easing of the COVID-19 pandemic and Russia’s invasion of Ukraine. Since then, price rises have slowed across the Eurozone. The annual inflation rates in France, Italy, and Spain have experienced recent declines, aided by government subsidies and the reduction of subsidized rail fares in Germany. Despite these improvements, inflation in the Eurozone remains well above the ECB’s target of 2%.
One key question emerges: Why is inflation persisting? According to Lagarde, inflation persists due to its phased impact on the economy as different economic agents pass on costs to each other. While economists often focus on the risk of a wage-price spiral driving inflation, recent evidence suggests that rising corporate profits have been a significant contributor. The pursuit of business profits has led to price increases, even as energy prices have dropped since last year’s peak.
The IMF highlighted that rising corporate profits account for almost half of Europe’s inflation increase over the past two years, surpassing the rising costs of imported energy. Consequently, businesses have been shielded more than workers from the rising costs, with profits even surpassing their pre-pandemic levels while workers’ compensation remains below the trend.
These developments in the European economy indicate the challenges ahead, with inflation remaining persistently high. The measures taken by central banks to address this inflation, such as interest rate hikes, may impact economic growth. Balancing the need to tackle inflation without constraining growth requires careful deliberation and coordination among policymakers.